Do you understand what your manufacturing company is worth?
Whether you are reaching retirement or have received an offer to sell, it is crucial to understand what value means for a business. The value of a company is generally determined by using three different approaches:
- Asset approach: The asset approach is used by determining the fair market value of the assets and liabilities inside a business. This method uses appraised or actual values at a given date. In some instances, this method is the most probable and unbiased compared to the other two. However, it does not consider the earnings potential of the subject business.
- Income approach: The income approach either focuses on the business’s current or potential revenue and expenses. The value(s) are capitalized or discounted back to the date of valuation, respectively. This method is more complicated than the asset approach because it uses current or potential earnings, cash flows, and an estimated return rate. The income approach generally requires the highest level of professional judgment to determine a value.
- Market approach: The market approach compares similar companies that have been previously sold to determine a value. This approach requires professional judgment since it relies on the economic and industry conditions and intangible value of a business associated with customer connections and team experience.
Due to most manufacturing companies relying heavily on assets for operations, business valuation experts will commonly use an asset-based approach to value the business. In terms of developing a value, professionals will typically review all valuation methods and determine which is most practical based on professional judgment.
Now that the big picture of determining a value has been established, it is essential to investigate more company-specific attributes.
- What industry does the company operate in? What is the current economic landscape?
- How has the company performed financially in the past, and how does it expect to perform in the future?
These are all valid questions that should be answered when beginning the process of preparing a business valuation.
To cater to the topic at hand, we will start by analyzing the subject company’s industry. The manufacturing industry is generally defined as companies engaged in transforming raw materials into new products using mechanical, physical, or chemical methods. In some instances, assembling of parts into new goods is included in this industry. Finished products may be sold directly to consumers or wholesalers for resale. In general, companies in this industry heavily rely on debt financing and are asset intensive. Companies in this industry vary significantly due to the products each business manufactures.
According to the IBISWorld August 2020 Report for Manufacturing in the United States, over the five years to 2025, the manufacturing sector’s revenue is forecast to return to growth. Sector revenue is expected to increase at an annualized 3.6% rate to $5.6 trillion over the five years to 2025. Rebounding commodity prices and renewed demand, both in the United States and abroad, are anticipated to facilitate accelerated revenue expansion for manufacturers. The report later discusses the uncertainty surrounding the COVID-19 pandemic and that forecasts do not provide a guarantee. Regardless, the industry consensus remains optimistic for manufacturing companies to experience growth in the foreseeable future.
A term often used for industry-specific business valuations is “multiples.” Buyers and sellers in the market want to know what type of multiple will be received for a business’s potential sale. A multiple is a number generally used to convert earnings before interest, taxes, depreciation, and amortization (EBITDA) or sales into a business value.
Example: If the current multiple of EBITDA in the manufacturing industry is 4.5, a company with current earnings of $100,000 would expect a fair market value of roughly $450,000.
While multiples can be skewed by company size and outlying sales transactions, it is an excellent way to develop a range of value for a subject business.
One commonly used method to determine if a manufacturing business meets expectations is comparing it to current industry benchmarks and key performance indicators. To understand how indicators affect value, it is important to be aware of the most common in the manufacturing industry:
- Capacity utilization
- Changeover time
- Customer return rate
- Cycle time
- Equipment effectiveness
- On-time delivery
- Planned maintenance %
- Schedule attainment
Note: The key performance indicators above may not apply to every manufacturing company based on specific operations.
If applicable, it is essential for business owners and managers to know how each is calculated and how their business continually compares to industry standards. Business valuation professionals should have access to research databases that collect each sector’s information within an industry. Common data used are industry benchmarks, multiples for sale, and previous sales reported to the database. All of the information provided for each sector is used in a business valuation to determine if a subject company meets the industry’s expectations.
Questions about your Manufacturing Company’s is Worth?
If you are interested in learning what creates value in a business or want to know more about the steps to complete a business valuation, please contact our team today! Our team of Certified Valuation Analysts are experienced in practicing all the above valuation approaches to perform credible business valuations for a wide variety of clients.